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Standalone Retirement Trusts: A Crucial Component of Estate Planning

Posted on: December 14th, 2016
For most Americans, the majority of one’s wealth is held in retirement accounts. When it comes to inheritance and estate planning, special considerations are necessary to ensure that these assets are protected and distributed according to the account holder’s wishes. It’s critical for law practices to have knowledge of all the options available for retirement asset transfer, in order to best serve client needs in this area.
 
Typically, retirement assets, such as IRAs, are passed via beneficiary designation. For example, for a married couple with children, it would be common to designate the spouse as primary beneficiary and children as secondary. In certain scenarios, however, it is advantageous to name a trust—rather than a particular individual—as the designated beneficiary. Once the retirement account becomes inherited by a non-spouse beneficiary (i.e. children), it is important to understand that IRS regulations treat this inherited retirement account differently. Specifically, once inherited, the beneficiary is obligated to begin taking required minimum distributions (RMD) from such funds within a more immediate time horizon of either five years or over the beneficiary’s life expectance (known as the “stretch”). The goal in planning for inheriting retirement assets is to maximize the stretch so that the tax-sheltered, long-term growth benefits of retirement accounts are maximized.
 
IRAs and other retirement instruments were designed precisely for a specific purpose: retirement. They were not intended as a savings mechanism for future generations. Tax laws work according to this assumption, and so foresight and planning are necessary when including such holdings in an estate to be passed on to beneficiaries. Trusts can serve as an appropriate conduit to protect and preserve these assets.
 
Not all trusts are created equal, however, and each type will carry benefits and costs when working in the context of retirement accounts. Attorneys often recommend naming a living trust as the
beneficiary of. This may have drawbacks, including a more fixed distribution schedule and the lack of creditor protection. Even worse, the IRS may a not consider the revocable living trust as a designated third party beneficiary, resulting in the assets becoming immediately, taxable income. Many attorneys are unaware of these and other tax implications that revocable living trusts have on retirement assets.
 
Enter the standalone retirement trust (SRT). The SRT is a specific type of trust that, upon the death of the retirement account holder, is designed to allow retirement assets to grow tax deferred by ensuring that the trust qualifies as a designated beneficiary. It also functions to protect the inheritance from future creditors of the beneficiary. Furthermore, naming a trust as a beneficiary may be preferable in situations where the intended beneficiary is a minor, is otherwise not able to make financial decisions, or where a specific structure of asset allocation is desired—such as with multiple children or blended families.
 
Thus, when offering an SRT, we should keep three main goals in mind:
 
1)  We want to “maximize the stretch” and allow for the tax sheltering that an IRA and other retirement instruments provide. The primary growth engine for these retirement accounts is that they can accumulate tax-free over an extended period of time. When these assets are transferred from account holder to beneficiary, special planning is needed to preserve this tax-deferred status. Otherwise, assets will be liable to taxes upon transfer and remove the primary growth benefit of such savings.
 
2)  We want to provide creditor protection. In light of the recent Supreme Court case, Clark v Rameker (2014), inherited assets are not shielded from creditor claims in bankruptcy proceedings.1 Rather, they may be treated as income and assets of the beneficiary, and thus, may be claimed by creditors seeking payment. In order to protect such retirement assets from creditors, SRTs provide a wall of separation between trust assets and a beneficiary’s creditors.2
 
To protect from creditors, the SRT offers asset protection features of general irrevocable, third-party trusts. The SRTs achieves this goal by acting a wall of separation between trust assets and the beneficiary.3 Creditors therefore do not have access to such funds. In this way, SRTs help preserve retirement assets for maximum growth over time.4
 
3)  We want to provide structure for how retirement funds may be used. This includes consideration of the timing and nature of allocations and distributions. Naming a beneficiary directly limits this structured distribution option, as the beneficiary will have full rights over and access to the funds, inheriting them as income. If one names a trust as beneficiary, the trust can contain stipulations concerning disbursements.
 
When drafting an SRT to provide structured distributions for a beneficiary, it’s important to know that there are two main types of trust options: 1) conduit trusts and 2) accumulation trusts. The former requires all distributions from a retirement account also be distributed to the trust beneficiary, which results in limited protections. The conduit trust also. The accumulation trust allows the trustee to retain retirement distribution assets in the trust, which his ideal when looking to provide structure around distributions. Each has advantages and disadvantages that should be considered when planning, including the types of beneficiaries permitted and manner in which distributions are calculated. These differences will also have distinct tax implications.
 
One recommendation for adopting SRTs in your practice is to offer them as part of a package of estate planning tools. Rather than presented to clients as an optional add-on, which they might deem unnecessary, SRTs should be included along with wills and living trusts as a crucial part of the full scope of estate planning. SRTs should not be regarded as competition substitute for a living trust, but rather combined and offered as a bundle to provide comprehensive protection of assets and a client’s estate.
 
Any client who has a retirement account should be made aware of the benefits of SRTs. Ideally, the standalone retirement trust will soon take on a larger, foundational role in estate planning strategy—right there on the checklist along with will, revocable living trust, power of attorney, etc.
 
For additional information please contact our office at (978)319-6006, or justin@jpestateplanning.com
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